The combination of MACD (moving average convergence divergence indicator) and SMA (simple moving averages) 200 as a strategy may seem very basic and simple in design. But, it can provide valuable information about the market that can help traders make more informed decisions while trading. Before diving deeper into the strategy let us first understand how MACD and SMA works.
What is MACD?
MACD or Moving Average Convergence Divergence is a technical indicator that helps identify the price trends, their momentum, direction and a potential reversal. It is based on the relationship of two exponential moving averages or EMAs. MACD can easily be calculated by subtracting the 26 period EMA from the 12 period EMA.
MACD = 12 period EMA – 26 period EMA
Every trader has his own methods to interpret the MACD but the most common methods are crossovers, divergences and fast rise or fall of the MACD line.
Now how do one trade the MACD line?
MACD are mostly displayed with a histogram which shows the distance between the MACD line and its signal line. When the MACD line falls below the signal line then it indicates a bearish signal and when the MACD lines rises above the signal line it indicates a bullish signal. One of the drawbacks of the MACD is that it also produces many false positives as well. There are many other ways to trade a MACD but this concise version was to help you understand the MACD + SMA strategy, now let’s move on to SMA.
What is SMA?
SMA or Simple Moving Average is the easiest moving average to construct. In simple words it is the average price over a specific time period and the word Moving means it is plotted on the chart bar by bar so it is always moving hence the Simple Moving Average. It can easily be calculated by adding the recent prices and then dividing that figure with the number of time periods in the calculation range.
SMA = A1 + A2 + A3 …. / n
- A = the price of an asset at period
- n = the number of total periods
The most common use case of the SMA is to identify the direction of the trend and also hints the trend changes. 200 SMA (previous 200 bar average) for the long term trend and the 50 SMA (previous 50 bar average) for short term trend.
Now that you have a more clearer picture of how the MACD and SMA work, we can move onto the strategy.
MACD + SMA 200 Strategy Explained
The combination of the classic MACD (Moving Average Convergence Divergence) and the 200-period SMA (Simple Moving Average) forms a trading strategy that is both straightforward and effective. This strategy can help capture the market trend while also filtering out the trades that go against the prevailing market trend. By mixing the long term trend indicator using the 200 SMA and the short term momentum confirmation using the MACD traders can make higher winning setups.
At its core the strategy works like this:
- We will take a long position if the MACD histogram and the MACD momentum both are above zero and the fast moving MACD average is above the fast moving MACD average.This helps us ride the trend instead of trading against the trend.
- SMA 200 will act as an additional long filter and the price needs to be above the 200 SMA line for a long confirmation.
- Basically the trend + momentum must agree to each other for this strategy to actually work and for the short the strategy is the same just inverse.
For the worst case scenario, if nothing goes as planned there is also a filter baked into this strategy. A maximum equity drawdown filter of 50% is enforced and if this threshold is hit the strategy will automatically stop trading. This helps us to protect the account from massive losses in choppy markets.
